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Key money refers to a fee paid by a lessee to a landlord or property owner to secure, renew, or extend a lease. Key money may be synonymous with a security deposit in some countries (such as in the United States) or a payment on top of a security deposit in other countries (such as Japan).
When not synonymous with a security deposit, key money can be viewed as a bribe to incentivize the lessor to rent the property to the lessee – for example, providing a substantial amount of key money to a lessor to secure a lease in an extremely tight rental market. Laws on the payment of key money, and its permitted amount, varies by jurisdiction.
In the case where key money is seen as synonymous with a security deposit, the amount may be used to cover nonpayment of rent or damage to the rental unit. Under the aforementioned case, the key money is usually held in escrow. The net amount (key money minus any rent non-payments and damage deductions) is returned to the lessee once the lease expires.
The context on whether key money is synonymous with a security deposit or a bribe depends on the jurisdiction. Uniquely, in Japan, key money (called 礼金 in Japan) is neither a security deposit nor a bribe. Rather, it is a common payment on top of rent and a security deposit.
The theory behind the commonality of key money in Japan is that the post-World War II era experienced a severe housing shortage, which put lessors in a position of choosing lessees who paid an initial fee (key money) to secure the lease.
The amount of key money required in Japan is at the discretion of the lessor, but the typical practice is one to three months of rent. With that said, it is not uncommon to see the amount of key money be equivalent to six months of rent.
Although key money is common in Japan, in recent years, an increasing number of lessors and real estate agencies no longer resort to the payment of key money. It is often seen in regions with a weak rental market. According to Real Estate Japan, about 46% of rental properties in the country do not require key money.
Question 1: Tim owns a restaurant business and is looking to establish a new location in Kyoto, Japan. He finds a building (“Building A”) for rent near a high-income neighborhood and a shopping mall. The lease agreement calls for a monthly payment of $5,000 and an upfront security deposit of $10,000.
Tim notes that several individuals are interested in renting Building A and decides to provide $15,000 in key money to secure the lease. Calculate the one-year cash outflow required by Tim for Building A in the case of (1) no payment of key money and (2) payment of key money.
Answer:
Question 2: Tim looks at the opportunity cost of renting Building A versus renting another building with the same lease structure (a monthly payment of $5,000 and an upfront security deposit of $10,000) situated in a less-desirable geographical location (“Building B”). He finds that he will earn $20,000 less in the first year of business if he rents Building B. Is providing $15,000 in key money to secure the lease of Building A rational?
Answer: It would be rational for Tim to secure the lease of Building A by providing $15,000 in key money over renting Building B and earning $20,000 less. Assuming the cash flows in year two and beyond are similar, the maximum amount of key money that Tim should provide is $20,000.
Question 3: Tim notes that an individual (“Individual A”) is willing to offer key money of $30,000 to secure the lease of Building A. As an advisor to Tim, what course of action would you recommend?
Answer: Tim should conduct a net present value calculation for renting Building A versus Building B. The net present value differential should be used to determine the maximum amount of key money that Tim is willing to pay to secure the lease of Building A. For example, if the net present value differential is $75,000, Tim could offer up to that amount to secure the lease of Building A.
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